Economics

Saving

Too thin a cushion

AMERICANS probably aren’t saving enough. Savings come in handy in many circumstances: when buying a home, paying for a child’s education, retiring, or in cases of unexpected need. Yet despite aging populations and rising educational costs, America's savings rate has been falling. The figure below shows the saving rate (for January) the last 44 years:

The drop began in the 1980s, perhaps because the Great Moderation made people less fearful of economic uncertainty. When uncertainty returned during the financial crisis, and as credit conditions tightened, the saving rate shot up. Wage stagnation may also play a role; people expected better living standards and cut back on saving to raise consumption. The saving rate fell again this past January. That may reflect greater economic optimism or the return of the full payroll tax, which lowered take-home pay. Rather than decrease consumption people may have saved less.

The falling saving rate is a worrying trend. A low stock of savings increases vulnerability to economic shocks. Expansionary economic policy has helped invigorate the economy by boosting consumption, through low interest rates. People save more during recessions—and more then businesses care to invest, leading to underutilised resources—so boosting consumption increases aggregate demand and jumps starts recovery. With saving rates already so close to zero, the government might have had better luck boosting the economy through its own dissaving, via deficit-funded stimulus, than through trying to encourage such behaviour in strapped households. And over the longer run, policies that discourage saving look foolish at current saving rates.

What’s interesting about the long term trend is that it coincides with the period when private pension accounts became more popular (the figure above counts 401(k) programmes and contributions to defined-benefit plans). Since 2006 firms could auto-enroll their employees: they could automatically put some of their wages in the accounts, unless explicitly told otherwise. This increased participation in these accounts. According to the Wall Street Journal, contributions to 401(k) plans have increased 13% since 2006.

There’s mixed evidence on whether pension accounts create new saving: whether or not people who have accounts save more or simply save less using other sources. For for active savers, people who normally save, access or auto-enrolment doesn’t change overall saving. But for passive savers, people who normally wouldn’t save much, auto-enrolment creates new saving that normally wouldn’t have existed. Passive savers tend to be younger and have lower incomes than active savers.

And this is the population that isn’t saving enough to begin with. They should be saving more for distant retirement and for precautionary reasons. The figure below shows average amount median income earners had in liquid assets (savings accounts, CDs, and savings bonds) and retirement accounts since 1989 (in 2010 dollars) from the 2010 Survey of Consumer Finance:

People now have much more of their wealth in retirement accounts. That’s not surprising. Private pension accounts have become more popular and the population has aged. People should have more in their retirement account than in liquid savings. It takes a lot more money to finance retirement, decades of no income, than it does to finance your typical precautionary event. Retirement accounts generally earn a higher yield (because they are typically invested in riskier securities). The decline in liquid savings in worrying, however. It suggests people are less prepared for the shocks life throws at them. Thismay be due to many factors: slow income growth or that the low return on low-risk saving instruments, which reduces the incentive to save.

Interestingly, the lower levels of liquid saving may explain why there’s been an increase in the number of people taking out loans against their 401(k) plans or paying the penalty to draw on them early. Meanwhile, the average retirement account balance for people between 55 and 64 is $291,000, which will only provide about $12,000 a year in inflation-indexed income. Taking out a loan means a saver misses out on valuable accruals. But without another source of saving taking a loan against retirement funds maybe be a better financial decision than default on other obligations.

To me the sudden increase in 401(k) loans is less about myopia and more a symptom of under-saving. As people save less to liquid assets and are being defaulted into a 401(k) plan; it’s not surprising they turn to their main source of saving when times get rough. Rather than make savings more illiquid, we need to do more to make all forms of saving more attractive.

The government, in constructing a safety net, has made it unnecessary if not imprudent, to save. Saving for college means that your student qualifies for less financial aid. Saving for long term disability means that the nursing home gets all of your wealth before you qualify for Medicare. Saving for retirement means that your social security benefits will be subject to income tax. And forgoing current consumption (with zero financing on a new car) to save at a 1% return (about minus 1% in real terms) is obviously irrational.
Plus the economy would collapse if we didn't 'Spend, spend, spend!'

While I personally wouldn't want to pull from my 401(k) unless I really needed the extra cash flow, the 401(k) loan could be viewed as a diversification strategy for the portfolio. By temporarily removing that portion of your savings from the account, you are shielding it from current loses in the market and (depending on your creditworthiness to yourself) guaranteeing a specific rate of return for the loaned amount upon repayment. I believe my 401(k) demands an interest rate of 5 or 6%, which obviously is currently better than any of your typical non-equity options.

The Fed paper referenced in the article says that even a loan from a traditional 401(k) can be argued to not be hit by double taxation due to the after tax repayments being spread across 5 years. I'm still wrapping my head around that explanation, but agree that a Roth 401(k) would avoid the tax issues entirely.

When I read this, I couldn't help wondering about the correlation between American savings habits and the average returns of low-risk savings accounts. I naturally assumed that periods of higher saving either coincided or immediately followed periods of higher returns.

The average interest rate on a low-risk savings instrument was 5.2 percent in May 1975 (the month American savings peaked at 14.6 percent). Since 1960, average interest rates climbed to their highest in June 1986 (19.1 percent). However, American savings remained relatively constant, hovering around 7 percent in the period between January '90 and January '92. It appears that ~19 percent APY didn't do a lot to encourage better savings habits.

The data shows I obviously afforded rate too much credit for swaying American saving habits.

P.S: what would you do for 19.1 percent return on your savings account?

That's not an anything view; it's a statistical view. Think about Apple. They're holding on to billions in cash and can't find anything worth while to spend it on. And they wouldn't have all that money if there weren't customer demand for premium computing devices. If companies (like Apple) project weak consumer demand for the future (whether they'reselling goods or physical capital), the projected return on any productive investment is lower.

I haven't seen any data that show that "regime uncertainty" has had any movement in the past 30 years, but it could be out there.

I think you got it wrong.
You're taking a Keynesian view. But it's not the demand that makes the "high return investment". It's the right idea that makes it (supply), as my Apple example showed.

If you start propping up demand artificially, with cheap credit or anything, the only thing you do is diverting funds from possibly longer-term profitable investments to short-term ones that would be unprofitable otherwise, but which are now in demand as people suddenly get access to new money.
Eventually, all we're left with is a new debt bubble, that must be repaid back before starting reinvesting again.

That's why investment is down despite enough available funds.
Red tape, banking regulation, and regulatory regime uncertainty are other factors.

Look at the stats: there's a glut of savings in the market right now, especially when you look at corporate cash. Problem is that with depressed demand, there aren't a lot of high return investments out there. Investment (capital accumulation) is down, but not for any lack of available funds.

"The falling saving rate is a worrying trend. A low stock of savings increases vulnerability to economic shocks."
-> You only see savings as a buffer for rainy days?? Savings is what provides the economy with funds for capital accumulation. THIS is what this is a worrying trend.

"People save more during recessions—and more then businesses care to invest, leading to underutilised resources—"
-> So you're basically saying that SMEs don't have any issue to find funding at the moment as there is a surplus of savings around... Funny it doesn't look at all like I see it out there.
(granted there are also other factors involved)

"so boosting consumption increases aggregate demand and jumps starts recovery. With saving rates already so close to zero, the government might have had better luck boosting the economy through its own dissaving, via deficit-funded stimulus, than through trying to encourage such behaviour in strapped households."
-> This is quite naive. Government has been dissaving for decades already. Stimulus don't work, or at least only provide a short-term boost (and only in terms of GDP growth thanks to the very nature of the GDP equation), especially in an economy that's plagued by both public and private overindebtedness. You can't force people to spend. Supply-side is the solution, as demonstrated by Apple and other consumer electronics firms throughout and despite the whole crisis.

Everybody knows that the ideal form of government is a benign dictatorship. Perhaps the better question for McG is how he intends to assure that the dictator that we get is benign. Somehow that is the point where "it happens by magic!" always seems to enter into the discussion.

No, you're right, government workers don't game the system or use their contacts to garner special privleges. Politicians especially don't do any of this.

For example, you would agree that GW Bush made his way into Yale on his own merits? And you would agree that the folks that GW Bush met at Yale didn't open other doors for him that would be unavailabe if he had not made it into Yale, on his own merits?

You would also agree that somebody like President Obama, who has never had to release his transcripts or justify why people think he's intelligent, can be trusted to be intelligent purely based on the institutions that he attended? Further, there's no question how he got into Harvard by the very rare path that he took through Occidental, being a self-professed stoner...

No, they didn't go to those institutions for special privleges and nobody helped get them there and, even though they both went government, that was accidental as both men were just as motivated for the private sector...

I almost don't even understand the question- does being an alumnus of an institution bestow privleges or open doors for you by the connections you make there??? yes.

Have all the recent presidents and supreme court justices been alumni of the ivy league schools??? yes.

Being that the most powerful positions in society are occupied by alumni of the ivy leagues, in order to be within that group of power, is it not beneficial to be an alumnus as well??? yes.

Do powerful politicians manage to get their children into the ivy leagues despite their academic achievement for the obvious benefit of the certification??? yes

I believe it's a conclusion that it based on solid observations. I don't live in that world but it doesn't mean that I don't observe it. I'm not a Kennedy but I think we all know the privleges one has for being a Kennedy- you literally get away with murder.

As the government grows larger and the private sector shrinks relatively, the smarter way to play the game is spend money on those activities that gain you the most political connections. For this reason people are willing to spend a fortune to get their kids into Harvard or Yale- not to learn anything, but to make connections with people who have parents in government and will be in government so when government divides the spoils, they'll have access to the decision makers within government.

Whenever data is presented about the savings rate it is never clear if this rate is based on gross income, take home pay (which is post 401K contribution) or disposable income i.e. after paying monthly bills and living expenses.Which is it in the top chart? How about avergae monthly/yearly savings accumulation?

Well, the multiplier effect is a mysterious thing that nobody can quite figure, at least at the aggregate level. Clearly the multiplier for tools is apt to be more than the multiplier for lap dances. But I'll grant that IF, and to the extent, revenues are reinvested into higher efficiency/productivity, there's a positive multiplier.
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And I have no beef with McDonalds (or Whole Foods for that matter). They excel at meeting customer demand; if they didn't (unlike banks) they'd be out of business. Of course, it would be nice to have transparency as to the externalities of all businesses--especially those that fall on the consumer directly and become part of the value proposition.

Yep. Decades of unfettered fiscal and monetary 'management' have pretty much strip-mined the country's private wealth. Arguably it has wasted quite a bit of the public wealth as well; to wit our multi-trillion dollar deferred maintenance on critical infrastructure. The Founders would be apalled, and request their images removed from our currency. Suitable replacements would be Woodrow Wilson, Richard Nixon, Arthur Burns, Hank Paulson. Alexander Hamilton can stay, of course.